Fixed Income and Credit Risk
Friday, Jan. 4, 2019 2:30 PM - 4:30 PM
- Chair: Monika Piazzesi, Stanford University
A New Normal for Interest Rates? Evidence from Inflation-Indexed Debt
AbstractResearchers have debated the extent of the decline in the steady-state short-term real interest rate---that is, in the so-called equilibrium or natural rate of interest. We examine this issue using a dynamic term structure finance model estimated directly on the prices of individual inflation-indexed bonds with adjustments for real term and liquidity risk premiums. Our methodology avoids two pitfalls of previous macroeconomic analyses: structural breaks at the zero lower bound and potential misspecification of output and inflation dynamics. We estimate that the equilibrium real rate has fallen about 2 percentage points and appears unlikely to rise quickly.
Low Inflation: High Default Risk and High Equity Valuations
AbstractWe develop an asset pricing model with endogenous corporate policies that explains how inflation jointly impacts real asset prices and corporate default risk. Our model accounts for two important sources of nominal rigidity present in the data. First, nominal coupons paid to long-term corporate debt are fixed in the short run, that is, leverage is sticky. Second, in the short run, earning growth is less sensitive to variations in expected inflation than the nominal risk-free rate, that is, firm profitability is sticky. These features combined result in higher real equity prices and credit spreads when inflation falls. An increase in inflation has the opposite effects, but with smaller magnitudes. The relation between equity prices and inflation is thus asymmetric. In the cross-section, the model predicts the negative impact of inflation on real equity values and credit risk is stronger for low leverage firms. We find empirical support for our theoretical predictions.
The Term Structure of Credit Spreads with Dynamic Debt Issuance and Incomplete Information
AbstractWe investigate credit spreads and capital structure dynamics in a model in which management has private information regarding firm value and is able to issue both equity and debt to service existing debt. Rather than choosing to default, managers of investment-grade~(IG) firms who receive bad private signals conceal this information by servicing existing debt via new debt issuance. As such, firms with IG-commensurate spreads have zero jump-to-default risk (and hence, command zero jump-to-default premium), at least until their debt capacity is fully utilized and spreads have increased to "fallen angel" status. These predictions match observation well.
- G1 - General Financial Markets